The government has identified small and medium-sized entities (SMEs) as a major contributor to future economic growth. One factor that hampers the growth of SMEs is a lack of access to equity funding.
In order to alleviate this problem the government has added Section 12J to the South African Income Tax Act as a catalyst for equity funding for SMEs. Section 12J provides a marketing vehicle to venture capital companies (VCCs) due to the tax incentive.
A Venture Capital Company (VCC) is a company that accepts investments from any taxpayer (individual, trust or company). The VCC manages the collective investment and make investments in SMEs.
Individuals, companies and trusts (any SA taxpayer) investing through approved section 12J venture capital companies can deduct the full amount of their investment from taxable income in the tax year that the investment is made.
When considering whether Section 12J is applicable to any investment/acquisitions, one would need to determine whether any of the following elements exist and if so, then Section 12J will not have application to the investment/acquisitions:
1. the gross asset value of the target company exceeds R50 million on the date of the investment or R500 million in the case of mining;
2. the target company earns more than 20% of its income from investment income (for example, an investment into an investment holding company would not be permissible);
3. the target company operates with majority of its trade outside of South Africa;
4. the target company carries on one of the following “Impermissible Trades”:
a. any trade carried in respect of immovable property, other than a trade carried on as a hotel keeper (i.e. an investment in hotels, serviced apartments, holiday homes in specific estates and student residences may very well comply);
b. any trade in the financial services sector (for example, banking, insurance, money lending, hire-purchase arrangements, however, this does not prevent an investor from investing in technology within this sector);
c. any trade carried on in respect of financial or advisory services, including trade in respect of legal services, tax advisory services, stock broking services, management consulting services, auditing or accounting services; and
d. any trade carried on in respect of gambling, liquor, tobacco, arms or ammunition.
Are there any risks?
Yes, although you save up to 45% in marginal taxes, the underlying investments need to perform adequately for you to realise those savings and additional good growth.
Because of the size of the companies and the fact that the shares is unlisted will also make the investment more illiquid than shares listed on the JSE.
Example: A taxpayer earns R2 000 000 in rental income and:
1.1. No investment into the VCC
Income: R 2 000 000
Deductions: R 0
Taxable Income: R 2 000 000
Tax payable @ 45%: R 900 000
1.2. Invests R 1 000 000 into a VCC
Income: R 2 000 000
Deductions – 12J Investment: (R 1 000 000)
Taxable Income: R 1 000 000
Tax payable @ 45%: R 450 000
By investing with a professional s12J asset management company, you will derisk your investment portfolio, while adding much-needed diversification, tax efficiency and investments not generally found in a typical South African investment portfolio.
However, as with any other investment, an investment in a S12J company carries risk. Investors should therefore assess the investment strategy and mandate of the S12J company in order to ensure they fully understand the associated investment risk.
Please let us know if you have any questions